Print

What is the tax on capital gains?
Morningstar | 09­03­15

When you sell an asset and make a profit on it, it is known as capital gains. This is applicable to any
asset  ­  property,  stocks,  bonds,  mutual  funds,  art,  gold,  and  so  on  and  so  forth.  In  other  words,
when you sell your mutual fund units, you incur a capital gains tax.

Capital gains is further split into long term and short term. And the tax implication differs for equity
and debt funds.

Equity funds

An equity oriented mutual fund is one where a minimum 65% of the investible corpus is invested in
domestic equity.

So gold exchange traded funds, or Gold ETFs, are not treated as equity funds for taxation.

Even international funds are not considered as equity funds in the case of taxation even though they
invest  in  equity.  The  criteria  to  qualify  for  an  equity  funds  is  not  just  investments  in  stocks  but
stocks listed in India.

In  the  case  of  hybrid  or  balanced  funds,  if  at  least  65%  of  the  assets  are  invested  in  domestic
equity, they qualify as equity­oriented funds.

If you sell an equity mutual fund after holding it for a period of 12 months, then it qualifies for long­
term capital gains. As of now, long­term capital gains on equity funds is nil. So you pay no tax.

If you sell your equity mutual fund before this period, then it qualifies for short­term capital gains,
which is 15%.

Another  feature  of  an  equity  fund  is  that  dividends  are  not  taxed.  The  dividend  is  tax  free  in  the
hands of the unit holder. Neither does the fund house have to pay any dividend distribution tax.

Debt funds

The  non­equity  funds  qualify  as  debt  funds  for  the  purpose  of  taxation.  So  this  would  include  all
types of debt funds, international funds, monthly income plans, or MIPs, and Gold ETFs.

Short­term capital gains would be levied if the holding period is less than 3 years. Short­term capital
gains  are  added  to  the  income  and  taxed  as  per  the  individual's  income  tax  slab.  From  a  tax
perspective,  it  is  obvious  that  debt  funds  no  longer  offer  tax  advantages  over  fixed  deposits  if  the
holding period is less than three years.

If you sell the asset after holding it for a period of 36 months, or 3 years, it qualifies as long­term
capital gains. This is 20% with indexation.

Indexation is the process that takes into account inflation from the time you bought the asset to the
time you sell it. The way it works is that it allows you to inflate the purchase price of the asset (in
this case the mutual fund units) to take into account the impact of inflation. The end result is that
you get the benefit of lowering your tax liability.

Dividends  received  in  the  case  of  a  debt  fund  unit  holder  are  exempt  from  tax.  However,  the  fund
house has to pay a dividend distribution tax, or DDT, before distributing this income to its investors.
The DDT is deducted by the asset management company prior to the disbursal of dividends. So, no
tax on dividends is payable in the hands of the investor.

All the tax rates mentioned above do not include surcharge and education cess. 

Source: www.morningstar.co.in
All you wanted to know about Mutual Fund
taxation
Ankur Choudhary / 22 June 17
"There may be liberty and justice for all, but there are tax breaks only for some."
Most of us are familiar with income tax where the level of your income from your profession determines the
tax rate. Currently there are four slabs - 0%, 5%, 20% and 30%.
Just like this is not the only type of income that exists, this income tax is not the only type of 'income' tax that
exists.
Income (or more correctly gains/profits) received from sale of certain assets like gold, real estate, and financial
assets like Mutual Funds, stocks, bonds etc is not treated as ordinary income for taxation.
These gains are called Capital Gains (the assets are called capital assets) and the tax applicable is called Capital
Gains Tax.
Capital Gains Tax depends on the asset
Unlike regular income tax which does not depend on the type of your profession (whether you are a techie
working in an MNC or a plumber doing odd jobs), capital gains tax depends on the type of the asset that
produced the gains - the tax on FD is different from real estate which is different from stocks and so on.
So, 1 lakh interest gained from your FD will be taxed differently from 1 lakh profit made by selling real estate, or
from 1 lakh profit made in stocks or Mutual Funds. Even within Mutual Funds, equity Mutual Funds are taxed
differently from non-equity Mutual Funds.
Short Term vs Long Term Capital Gains & Tax
There is another interesting concept that is applicable to Capital Gains Tax that is not seen in normal income
tax. The tax liability also depends on how long you have held the asset for i.e. the date of sale - the date of
purchase.
Based on the holding period, your gains will either be categorised as Short Term Capital Gains (STCG) or as Long
Term Capital Gains (LTCG). The tax applicable on STCG is called STCG Tax and that on LTCG is called LTCG Tax
(duh!).
Not only this, different assets have different cut-offs for the holding period to be classified as short term or long
term.
So here is the basic 'algo' for figuring out the applicable capital gains tax rate:
Capital Gains -> which asset? -> whether long term or short term (according to the asset) ?-> look up applicable
tax rate for that asset for that period.
Quite a mouthful, right?
You might be wondering why all this un-necessary bother. Why can't we just tax everything like the regular
income tax and be done with it?
Apart from the fact that this will lead to wide-spread unemployment amongst the CAs, the reason for going
through so much trouble is that Capital Gains Tax is generally less than the income tax - in many cases even
substantially less.
Just remembering this fact will make you a much smarter investor (and a nicer human being - at least towards
us and your CA).
Capital Gains Tax have to be paid on your own
Most of us who are salaried or have professional income are used to the concept of TDS - Tax Deducted at
Source.
One misconception about TDS is that TDS is the same as tax liability. It is not. TDS is just a way for the
government to check tax evasion by asking the employer/payer to deduct some tax at the source even before
the income reaches you. The concept of TDS may not even exist in other forms of income e.g. capital gains
income. But that does not mean that there is no tax liability for that income.
Your final tax liability can be (and usually is, in case of non-salary income) different from the amount of TDS
deducted.
If your tax liability exceeds the TDS amount then you have to pay it on your own via a payment (known as
a challan) to the income tax department.
If your tax liability is lower than the TDS amount then you claim the difference as a tax-refund while filing your
tax returns.
TDS on Capital Gains
There is usually no TDS on your capital gains income - i.e. while selling an investment there is no TDS deducted
from your profits. This does not mean that your gains are tax-free. It just means that you need to take care of it
on your own.
Now let's look at how Capital Gains Tax applies to some of the popular investment options that most of us use.
1. Fixed Deposits
This one is simple.
Firstly, interest income earned from Fixed Deposits is not tax free - it is fully taxable.
Secondly, FD is not even considered a capital asset so actually all the interest income is treated as ordinary
income and taxed at your income tax level (irrespective of the tenure of FD).
So if you are in the 30% tax bracket and your bank is giving you a 7% interest on your FD, your tax liability is
30% on that interest i.e. 30% of 7% = 2.1%. So your actual after-tax interest rate is just 7 - 2.1% = 4.9%!
Similarly, if you are in the 20% tax bracket, your after-tax FD returns are going to be 7% - (20% of 7%) = 5.6%.
What about TDS?
Banks are liable to deduct TDS at the rate of 10% on the interest earned, if the interest income for the year is
more than Rs. 10,000.
Again, don't confuse TDS with tax liability. Just because TDS is deducted at 10% does not mean your tax liability
is also 10%. It could be higher or lower depending on your income level. Gotta keep track of it on your own.
2. Real Estate - property, land, house etc
Real estate is a capital asset so profits gained from sale of real estate come under Capital Gains.
If the holding period was less than 2 years, the gains will be marked as Short Term Capital Gains (STCG). STCG
for real estate is clubbed with your total income and taxed at your income tax level.
If the holding period was more than 2 years, the gains will be marked as Long Term Capital Gains (LTCG). LTCG
for real estate qualifies for indexation benefit i.e. in order to compute your gains, instead of using your actual
purchase price you can use a higher inflation-adjusted price.
So LTCG = Sale price - (actual purchase price + inflation over the holding period)
The tax liability is then 20% of the LTCG computed above (irrespective of your income bracket).
Because of the indexation benefit, LTCG can be significantly lower than the actual gains, thus lowering your tax
liability by a lot - in some cases even 0 when the gains are less than inflation!
What about TDS?
A TDS of 1% on high value transactions was recently introduced by the government to check tax evasion in real
estate transactions but apart from that you need to compute your tax liability and pay the tax (or claim refund)
on your own.
3. Stocks
Stocks (along with Equity Mutual Funds - more on that below) have the most lenient capital gains taxation.
If the holding period was less than 1 year, the gains will be marked as Short Term Capital Gains (STCG). STCG for
stocks will be taxed at 15% flat (irrespective of your income tax level). That is even if you are in the 30% tax
bracket, short-term profits booked from stocks will be taxed at only 15%.
Remember capital gains tax arises only when you sell your asset (stocks in this case). So if you are just holding
your stocks while they increase in price, there is no tax liability at the end of the year.
If the holding period was more than 1 year, the gains will be marked as Long Term Capital Gains (LTCG). Tax on
LTCG for stocks is ZERO! Even if you sell a stock for a 10x higher price, if the holding period is more than a year,
you wont have to pay ANY taxes on your gains.
No wonder most of the wealth of the richest people in the world has come from owning stock - higher growth
and lower taxes!
4. Mutual Funds
Mutual Funds invest in various assets like stocks, bonds, gold etc. so their taxation depends on the type of
Mutual Fund.
From a taxation perspective, there are only two kinds of Mutual Funds - Equity Mutual Funds and Non-Equity
Mutual Funds.
Also note that tax liability is the same for resident Indians as well as NRIs.
Equity Mutual Funds
These are Mutual Funds that invest at least 65% of their money in stocks and stock derivatives. Examples are
diversified equity funds, sectoral equity funds, balanced funds having more than 65% equity, arbitrage funds
etc.
The taxation of Equity Funds is similar to stocks. Along with stocks they are the most leniently taxed
investments.
If the holding period was less than 1 year, the gains from the sale of your equity Mutual Fund units will be
marked as Short Term Capital Gains (STCG). STCG for Equity Mutual Funds will be taxed at 15% flat (irrespective
of your income tax level). That is even if you are in the 30% tax bracket, short-term profits booked from Equity
Mutual Funds will be taxed at only 15%.
Again, remember that capital gains tax arises only when you sell your asset (stocks in this case). So if you are
just holding your Mutual Fund units while they increase in price, there is no tax liability at the end of the year.
If the holding period was more than 1 year, the gains will be marked as Long Term Capital Gains (LTCG). Similar
to stocks, tax on LTCG for Equity Mutual Funds is ZERO!
So even if you make crores over your lifetime by investing in Equity Mutual Funds, you don't have to pay a
single rupee in taxes as long as the holding period for each fund is greater than 1 year.
What about TDS?
For resident Indians, no TDS is deducted on the sale of Mutual Fund units, whether short-term or long-term.
Any (short-term) capital gains tax liability has be to paid by you on your own.
For NRIs, TDS at 15% will be deducted for redemption from equity mutual funds within 1 year (STCG) whereas
no TDS will be deducted for sale of equity mutual fund units held for more than a year (LTCG).
Non-Equity Mutual Funds (Debt Funds etc)
These are Mutual Funds that invest less than 65% of their money in stocks and stock derivatives. Examples are
pure debt funds of all types - liquid, short term etc, hybrid funds holding less than 65% equity, gold funds etc.
The taxation here is not as lenient as Equity Mutual Funds and is similar to real estate - still making it better
than Fixed Deposits, especially in the long term.
If the holding period was less than 3 years, the gains will be marked as Short Term Capital Gains (STCG). STCG
from Non-Equity Mutual Funds is clubbed with your total income and taxed at your income tax level.
If the holding period was more than 3 years, the gains will be marked as Long Term Capital Gains (LTCG). Like
real estate, LTCG from Non-Equity Mutual Funds also qualifies for indexation benefit i.e. in order to compute
your gains, instead of using your actual purchase price you can use a higher inflation-adjusted price.
So LTCG = Sale price - (actual purchase price + inflation over the holding period)
The tax liability is then 20% of the LTCG computed above (irrespective of your income bracket).
Because of the indexation benefit, LTCG can be significantly lower than the actual gains, thus lowering your tax
liability by a lot - in some cases even 0 when the gains are less than inflation!
What about TDS?
For resident Indians, no TDS is deducted on the sale of Mutual Fund units, whether short-term or long-term.
Any (short-term) capital gains tax liability has be to paid by you on your own.
For NRIs, TDS at 30% will be deducted for redemption from non-equity mutual funds within 3 years (STCG) and
in case of LTCG, TDS at 20% with indexation will be deducted for sale of debt mutual fund units held for more
than 3 years.
Debt Mutual Fund vs FD - Who wins on taxes?
Debt Mutual Funds are 10 times more tax efficient than Fixed Deposits while providing similar safety and
returns because of indexation benefits.
In FD all gains are taxed at your current income tax level irrespective of how long the FD was kept for.
So if you are in the 30% tax bracket, a 5 year FD at 7% pa will attract a tax of 30% of 7% = 2.1%. So your after-
tax returns will be 7%-2.1% = 4.9% only!
Same investment made in Short Term Debt Mutual Funds for 5 years will be eligible for indexation under Long
Term Capital Gains.
If the inflation during those 5 years is 6%, your tax liability will only be 20% of (7%-6%) = 0.2% - one-tenth of
that of FDs and your effective after-tax returns will be 7%-0.2% = 6.8% !
If inflation is 7% or more, then the taxes will be zero!
There are more reasons to prefer Short Term Debt Funds over FDs but this is one of the biggest.
Capital Losses
What if instead of capital gains, you have a capital loss while selling your property or mutual fund units?
Obviously you don't have to pay any taxes if you have not made any money, but there is more.
Short Term Capital Losses can be set-off against other Short Term and Long Term Capital Gains (and not against
your ordinary income) i.e. a short term loss booked in stocks or equity Mutual Funds can be used to cancel out
all or part of short term capital gains in Debt Funds.
Long Term Capital Losses can be set-off against other Long Term Capital Gains only. Note that since there is no
LTCG tax on stocks and equity Mutual Funds, any long term loss in them is a dead loss and can not be set-off
against any thing else.
Also, if you are not able to set off your entire capital loss in the same year, both Short Term and Long Term loss
can be carried forward for 8 assessment years.
Quite considerate, right?
You can read more about setting off Capital Losses here.
Capital Gains Report
Okay, while all of this is important to lower our tax bill, it still is a lot to keep track of especially all the dates and
durations etc.
And if you have invested in Mutual Funds via a SIP, then there are so many transactions, each one month apart.
When you sell in one go, capital gains tax for each of those instalments needs to be computed separately as
some of them might be short term while others might qualify for long term.
Fortunately for you, it is going to be a breeze. You can now download your Capital Gains Report for your
investments on Goalwise from your dashboard under the Downloads > Reports section. In this report you will
be able to see how much Short Term and Long Term Capital Gains you have realised for all your equity and debt
funds separately. We have taken care of all the calculations regarding durations etc.
Note that the report contains only the capital gains and not your tax liability on those gains. The final tax
liability will still need to be calculated by you as that depends on your exact income level for that year and other
capital gains or losses that you might have incurred elsewhere which only you (or your CA) will know. But that
should be a lot easier once you have the Capital Gains report.
Mutual Funds are probably the most tax efficient investment options out there for both equity and debt and
being aware of the tax implications will let you earn more returns without taking any extra risk. :)